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Behavior Survey: Growth-Tilted Investors With Advisors

We have been reviewing the results a survey that I created in February 2010 that was completed by 980 individual investors who subscribe to either Morninstar.com and/or Morningstar investor newsletter publications. The purpose of the survey was to gauge investing behavior and choices and how influential these choices are in the investment decision-making process.

The survey was also done to learn more about the four behavioral investor types that I developed (that we have been reviewing over the past two and a half years) and how financial advisors can be better prepared to work with them. Of the 980 surveys that were completed, 308 were completed by investors who use financial advisors. Here we will be reviewing answers to bias questions of investors using financial advisors.

This information can be highly relevant to advisors in their quest to serve clients in the best way possible. It is important to remember that the Morningstar investor survey is composed of a very specific type of investor population so let's review that now. (More details on the survey can be found in the original article.)

The population of survey takers in the Morningstar universe was generally defined as "mostly male, mostly experienced (experienced having a double meaning here--experienced in the sense that they are not new to investing and experienced in the sense that that over half of the survey takers were over 60 years old), and mostly do-it-yourself" investors. What this means is that the majority of survey takers were proactive, engaged and self-directed investors which, naturally, is only a subset of all investors. The populations of survey takers that use financial advisors are likely to be somewhat less self-directed but we can assume since they subscribe to Morningstar services, they are still somewhat self-directed. It is important to remember not to extrapolate what is learned in this set of articles to the general population of investors because it contains many passive and/or unsophisticated investors as well as "middle of the road" investors who are somewhat engaged but don't have the time or aptitude for more. And of course, the general population of investors contains a higher percentage of women and young investors. For simplicity, I will call the investors who took the survey that use financial advisors "PEM-FA investors" going forward to stand for Proactive, Experienced and Male investors who use financial advisors. We will now review the biases of growth-oriented investors.

Biases of Growth-Oriented InvestorsConservatism BiasBias Type: CognitiveBias Description: Conservatism bias occurs when people cling to a prior view or forecast at the expense of acknowledging new information. Growth-oriented investors often cling to a view or forecast, behaving too inflexibly when presented with new information in their quest for portfolio gains. For example, assume an investor purchases a security based on the knowledge about a forthcoming new product announcement. The company then announces that it is experiencing problems bringing the product to market. The growth-oriented investor may cling to the initial, optimistic impression of the new product announcement and may fail to take action on the negative announcement. Here is the survey question related to Conservatism bias.(View the related graphic here.) Commentary: With more than 90% of respondents answering in the affirmative, this is good news for advisors. However, in my experience I have seen many an investor stick too closely to their beliefs about investment they make based on their own research. Advisors need to monitor their clients' behavior related to conservatism bias because clients often don't realize they are engaging in this behavior.

Availability BiasBias Type: CognitiveBias Description: Availability bias occurs when people estimate the probability of an outcome based on how prevalent that outcome appears in their lives. People exhibiting this bias perceive easily-recalled possibilities as being more likely than those prospects that are harder to imagine or difficult to comprehend. As an example, suppose a growth-oriented investor is asked to identify the "best" mutual funds. Many of these investors would perform a "Google" search and, most likely, find funds from firms that engage in heavy advertising--such as Fidelity or Schwab. Here is the survey question related to Availability bias.(View the related graphic here.) Commentary: These numbers appear to be in the range of being correct. However, my experience tells me that more than 38% of investors make financial purchase decisions based on name recognition. Similar to conservatism bias, this is a bias that is difficult for investors to realize they are engaging in. Advisors need to monitor the clients their clients behavior for this bias as well as themselves - often the mutual fund companies that market themselves the most tend to be "top of mind."

Representativeness BiasBias Type: CognitiveBias Description: Representativeness bias occurs as a result of a flawed a perceptual framework when processing new information. To make new information easier to process, some investors project outcomes that resonate with their own pre-existing ideas. A client might view a particular stock, for example, as a value stock because it resembles an earlier value stock that was a successful investment - but the new investment is actually not a value stock. For instance, a high-flying biotech stock with scant earnings or assets drops 25% after a negative product announcement. Some investors may take this situation to be representative of a "value" stock because it is cheap; but biotech stocks don't typically have earnings while traditional value stocks have had earnings in the past but are temporarily underperforming. Here is the survey question related to Representativeness bias.(View the related graphic here.) Commentary: This is a bias that is not easily perceived so I was glad to see that at least 20% of this survey population said they were subject to the bias. It is likely that even more were subject to the bias but they found it difficult to imagine themselves in this situation. Investors often compare investments they are currently considering to characteristics of prior investments (a mental shortcut) especially when the prior investment was successful. With advice and guidance this bias can be overcome.

Self-Attribution (Self-Enhancing) BiasBias Type: CognitiveSelf-attribution bias refers to the tendency of people to ascribe their successes' innate talents while blaming failures on outside influences. For example, suppose an investor makes an investment in a particular stock that goes up in value. The reason it went up is not due to random factors such as economic conditions or competitor failures (the most likely reason for the investment success), but rather to the investor's investment savvy (likely not the reason for the investment success). Here is the survey question related to Self-Attribution bias.(View the related graphic here.) Commentary: This is a good sign that a majority of respondents believe that investment success is based on external factors such as the economy or industry conditions. Or perhaps the good advice of their financial advisor! Also, advisors can leverage this to their benefit when an investment or asset class doesn't work out: it can typically be explained by external factors.